Internationalising industry policy

One of the clichés of industry policy from the late 1970s on is that inward orientation is to be avoided – outward or export oriented policy is the go. There are lots of good reasons for this. We didn’t see those reasons and then failed to notice the empirical evidence that was building up that tariffs were a bad idea partly because we were to a substantial extent focusing on the wrong thing. Economic models up until the late 1980s tended to focus on inter-industry trade, so the problem with tariffs on (say) cars was that it led to Australia importing too few cars.

As a result it had overpriced cars, and because it imported too few cars, this increased the exchange rate sufficiently to crowd out some of the exporting we should have been doing in more efficient industries – like wheat, wool, iron ore and the odd bit of manufacturing that we had stumbled upon – like making cochlear ear implants (though that complicates the story a little because Cochlear got quite a bit of government assistance to get where it got).

In fact there was another reason tariffs and quotas were bad.  If you are going to assist car making, tariffs are a pretty bad way to do it because they systematically favour firms producing for the domestic market, and the chances are that the manufacturers with the most promise – the ones most likely to stumble into some global niche – as Cochlear did with their ear implants – are those that are exporting the most.

As a result we changed the way we assisted the industry at the same time as winding down its assistance as we should have.  We introduced export subsidies to match tariffs and at the same time reduced tariffs so that they are now at moderate levels.  The export subsidies were removed in response to complaints from trading partners under the GATT and to replace that assistance we moved to production/investment subsidy assistance. I don’t want to engage in whether this scheme is justified or not here, but at least in principle, if one has some commitment whether because of political necessity, or because one really does think that assisting the industry generates sufficient gains to justify the cost, other things being equal, subsidies make better sense than tariffs because they don’t discriminate against exports.

But of course this is all in the context of wanting to develop national industry. Today there are lots of government schemes whose objective – at least we are told – is not principally to do that but to achieve some other objective.   

The most important of them for the future is greenhouse industry policy. One thing you can bet on is that there will be lots of government money for research and development into all manner of greenhouse gas abatement policies. It’s good policy and it’s good politics, something that politicians will find impossible to resist (well there are exceptions but we’ll leave them to one side). But if governments are subsidising the development of intellectual capital on this subject there’s really no reason to insist on it being developed in one’s own country, and many reasons to insist on a global perspective so that the best firms can work on the problems in the best places to work on them.

Of course though it makes perfect sense, it isn’t politically realistic to suggest that a country will offer to subsidise scientists and capitalists from other countries to develop such things. But it is a worry that, as a result there will be much more duplication and wasteful spending of other kinds than there needs to be. If someone finds a good geothermal resource in Chile that still requires a lot of R&D, it’s off to the Chilean Government to get subsidies to develop the technology, not the Australian Government which might be much better placed in terms of expertise and in any event it might be Australian capital that develops the technology.

Like others we subsidise research and development that occurs within our shores. Yet I think there are obvious problems with this approach

1. If we are supporting R&D because we consider that capital markets do not provide sufficiently good means for bearing risk, then the argument is that some R&D will justify the subsidy with supernormal returns. But if that’s the case, it’s hard to see why one would subsidise R&D that will lead to foreign owned IP as these profits can be expected end up offshore. Further, we should be happy to fund Australian owned firms conducting R&D wherever they do it, as it’s likely to end up generating returns for Australians.
2. If we support R&D because we think there will be spill-overs, then it will still often be best to subsidise R&D that leads to domestically owned IP, because I expect that there fewer of the spill-overs end up outside the country.

All of this is fairly academic in one sense because at least one major reason we do as we do is that we have little choice. Various international treaties require us to provide foreign investors in Australia with the same rights to subsidies as domestically owned firms. And imagine that we did offer substantial subsidies for R&D for Australian firms operating offshore, then arguably the investment treaties require us to do the same for other (ie foreign owned) firms offshore. At which point we end up funding foreign firms to do foreign R&D.

Still, the issues are serious enough in greenhouse. It’s ridiculous that in this age of globalisation and emissions trading that not just R&D subsidies on greenhouse are balkanised into national efforts, but also other abatement initiatives, most particularly renewables targets. Australia is (apparently) a particularly propitious place to invest in windpower. Yet the subsidies for wind power are (mostly) offered by other countries ostensibly to reduce emissions, and yet subject to the industry policy constraint that the investment to which they give rise occur nationally.

If one tried to do end this idiocy quickly one wouldn’t get anywhere as people pointed to the kinds of ‘thin end of the wedge’ arguments as outlined in my example with foreign R&D above. But taking things more incrementally, one can suggest a direction for progress. Australia, or any other country could announce their preparedness to consider ‘offsets’ such that for any dollar that is spent from another country’s industry policy assistance programs in Australia, it would enable firms in that country to qualify for industry assistance up to the amount that had been spent in Australia.

Perhaps after a while we might move further towards more internationalised industry policy. But I’m not holding my breath.